NetApp reported third quarter revenues of $1.63 billion, up 4.1% from $1.57 billion in the year-ago quarter. Revenues were within the company’s guidance range of $1.575–$1.675 billion and slightly above the Zacks Consensus Estimate of $1.62 billion. The year-over-year revenue improvement was mainly attributable to solid performances by Software and Services, partially offset by Product revenues.

Product revenues were $1.06 billion in the quarter, flat year over year and accounted for about 65.1% of the total revenue. Growth in Branded revenues was offset by weak OEM revenues.

Software Entitlement & Maintenance revenues were $228.6 million, up 12.3% from $203.5 million in the year-ago quarter. The segment’s revenues represented around 14.0% of the total revenue.

Service revenues were $340.8 million, up 13.9% from $299.3 million reported in the year-ago quarter. The segment accounted for 20.9% of the total revenue.

Operating Results

NetApp reported gross profit of $964.9 million, which increased 6.2% year over year. Gross margin grew 120 basis points (bps) year over year to 59.2%, mainly due to product mix.

Total operating expenses increased 3.3% from the year-ago quarter to $777.0 million. Operating income increased 20.1% from the year-ago quarter to $187.9 million. Operating margin was 11.5%, up from 10.0% in the year-ago quarter.

Net income on a GAAP basis was $158.1 million, or 43 cents per share, compared with $119.6 million, or 32 cents in the prior-year quarter. The quarter’s result was above the company guided range of 29–34 cents.

Excluding the above-mentioned special items, but including stock-based compensation, adjusted net income was $188.5 million or 52 cents per share, compared with $151.5 million or 41 cents a year ago.

Balance Sheet & Cash Flow

NetApp exited the quarter with cash, cash equivalents and investments of $6.72 billion, up from $5.57 billion in the previous quarter. Receivables were $633.8 million, up from $615.0 million a quarter ago. Inventories decreased $40.3 million from the prior quarter to $172.9 million. The company bears a long-term debt balance of $994.3 million.

Cash generated from operations was $365.1 million compared with $336.4 million generated in the prior quarter. Capital expenditure in the quarter was $110.7 million, up from $67.1 million in the prior quarter.

Non-GAAP gross margin is expected in the range of 60.0–61.0%, while non-GAAP operating margin is projected at roughly 17.0%. GAAP EPS is expected to range between 43 cents and 48 cents, while non-GAAP EPS is expected between 65 cents and 70 cents. The company estimates shares outstanding of approximately 365 million and a tax rate of 16.0%. The Zacks Consensus Estimates for the fourth quarter and fiscal 2013 are 51 cents and $1.55, respectively.

Our Take

The quarter’s results were decent with the top and bottom lines surpassing the Zacks Consensus Estimates. Favorable product mix and cost optimization measures helped in margin expansion. Keeping in mind the ongoing macro uncertainty caused by the European debt crisis and federal budget cuts, management guided a cautious fourth quarter.

But we believe that NetApp can witness strong product demand with its newly launched 3250 and 3220 platforms, the new series of midrange storage platforms.

Though new product refreshes, association with Cisco Systems Inc. (CSCO) and VMware Inc. (VMW), and ramp of ONTAP 8.1 are positives, we believe that uncertain IT spending patterns and growth prospects of its archrival EMC Corp. (EMC) may pose serious threats.